From Bootstrapped to Funded: When Should You Raise External Capital

Bootstrapping your startup is a great way to get it off the ground, but when should you raise external capital? Should you fall in with the “growth-at-all-costs” mindset prevalent in the business landscape just a few years ago? Or, is a strategic but consistent growth pace more conducive to success?

Investing personal funds and sourcing capital from family and friends is adequate for a startup in its pre-seed stage. Though several top companies have made it big without seeking venture capital. A great example is MailChimp, built almost entirely on bootstrapped funding.

Eventually, Intuit acquired the company for $12B in cash and stock in 2012. Let’s try another. Shopify’s founders built it as a shopping cart solution and ran the business independently on a revenue-based growth model. The company experienced exponential growth for six years without external capital.

Although these are notable success stories, not all startups are built alike. Companies cannot always rely on significant revenues in the initial stages to sustain growth. You’ll need external funding to take the company to the next level–for advertising, building the MVP, or hiring top talent.

The decision to raise capital from investors should be a strategic approach that aligns with your vision for the company. You’ll weigh in the pros and cons and factor in financial stability and the type of industry where you work.

A significant cash injection can undoubtedly spur rapid growth, but how do you know when should you raise external capital? What are the growth markers and industry benchmarks to consider before approaching investors? Let’s dive in and find out.

Understanding External Funding

Securing external funding or investment involves approaching accredited entities to obtain capital for the company. You’ll compile a list of investors, such as banking institutions, venture capital firms, angel investors, and private equity firms.

Depending on the sector in which you operate and other parameters, you’ll also consider approaching family offices and crowdfunding platforms. Additionally, consider adding accelerators and incubators to your list.

In the last few years, new classes of investors have emerged offering funds in smaller denominations. Think–microloans, micro VCs, and more. Don’t underestimate the value that operator angels and operator investors provide.

You’ll tap into these capital sources for more than just money. Founders can utilize their assistance and expertise for expansion, product development, and sales growth.

Regardless of the capital source you choose, expect investors to value the company, conduct due diligence, and offer terms accordingly. They will also require an equity stake in the company along with a share in the profits.

Value External Investors Bring to the Startup

Bringing in external capital has several advantages for a rapidly growing startup. Here are some of them:

• Bootstrapping, personal finance, and informal capital sources can only take the company so far. When poised for rapid growth, you’ll need more money to expand operations by purchasing equipment and renting facilities. You’ll hire additional talent to grow the team and invest in advanced customer acquisition solutions.
• Growing the company requires highly skilled individuals who specialize in various aspects of running operations. However, top talent comes at a price. External investment enables you to pay salaries and benefits that are essential for employee retention.
• Having ideated a marketable concept and created the MVP is not enough. You’ll need help with ensuring product-market fit and go-to-market strategies, which investors can provide. You can rely on them for invaluable industry-specific expertise, know-how, and guidance that can help take the startup forward. Access to contacts and mentoring are other advantages.
• Additional capital enables you to invest in innovative technology, infrastructure, and advertising to gain an edge over the competition.
• You’ll divert more resources toward developing better product features and adding products to the portfolio. Strategies like these ensure that you’re always one step ahead in the market.
• An incredible 35% to 80% of startups fail because they run out of runway or operating capital. A strategically timed cash infusion can help prevent this from happening to your new company. If you’re thinking about when you should raise external capital, a diminishing runway should be your cue.

Downsides of External Investment

While external investors and the capital they provide offer multiple benefits, it is essential to prepare for their potential downsides. Here’s what you need to know:

• The most significant downside is the risk of dilution as investors expect equity in exchange for capital. Each subsequent funding round involves giving up more equity and higher dilution. Investors may also propose appointing a representative to serve as a board member. Be cautious of the possibility of losing decision-making and control or, worse, being removed from the company.
• Bringing in investors and giving them stock makes you accountable to them. They expect returns, and you have certain obligations toward them, which adds to the stress of running the company. You could feel the pressure to push premature growth and expansion, which can be disastrous for an unstable startup. Also, be prepared for the expectation of unrealistic profits.
• Depending on the investor class you approach and their terms, you may have to agree to high interest rates. As in the case of debt financing, you may also have to offer collateral.
• Most investors offer capital with the expectation of an exit on the horizon. This exit can be in the form of a merger and acquisition (M&A) deal or an initial public offering (IPO). A lack of alignment with the founder’s goals and the investors’ liquidity timelines can be a source of conflict.
• Raising external investment involves extensive planning, paperwork, and financial evaluation. Investors will conduct thorough due diligence to assess your creditworthiness before offering capital. The process often takes away time and bandwidth from running and growing the startup organically. The founder’s time away from running and monitoring operations may not work well for the startup.

When Should You Raise External Capital

Even the topmost companies and unicorns worldwide must raise capital during their lifecycles. But the timeline can depend on several factors. Here’s a quick overview of the signs that indicate it’s time for your startup to get external support.

Timing the Capital Raise to Align with Market Conditions

Founders often time their capital raise to align with evolving market conditions. If your product is disruptive and timed perfectly to customer needs, you’ll need money to ramp up production. You’ll want to capitalize on the growing demand and capture the maximum market share possible.

Relying solely on revenues to fuel growth at this time may not be the most effective strategy. Then again, if the sector is evolving with innovations breaking into the market, you’ll need a capital infusion. You’ll use the money to invest in research and development, aiming to enhance product features.

Expanding your product portfolio could also become essential to maintain market positioning, retain customers, and secure credibility. Be aware that market conditions can impact your decision to raise funding in multiple ways.

An economic uptrend indicates that more investment is flowing into the market, and the mood of venture capitalists is upbeat. In this scenario, expect competitors to raise funding and grow quickly.

As a rule, fundraising should always be a carefully thought-out decision independent of external influences. You’ll ensure your startup is stable enough to sustain growth. However, an uptrend may bring you money on favorable terms and conditions, an opportunity you shouldn’t pass on.

On the other hand, an economic downturn could make it more difficult to secure capital. This is why it’s advisable to align your funding initiatives with market cycles.

Impressive Key Performance Indicators (KPIs)

The startup’s key performance indicators are a powerful metric to base your capital raising decision. If the KPIs indicate a consistent upward trend and a viable business model, it’s time to proceed. For instance:

• A robust month-over-month revenue growth rate and increasing profit margins
• Lower customer acquisition costs and churn rates indicate customer loyalty and high retention
• Rising Customer Lifetime Value (CLV) or the revenue the company generates from a customer throughout their relationship with the brand
  Improving market penetration
• Higher operational efficiency and lower costs, thanks to economies of scale
• A higher Net Promoter Score (NPS) indicates customer satisfaction levels. You’ll calculate this metric by deducting the number of customers who would not recommend the company (detractors) from the number of customers who favor the company (promoters).
• A lower cash burn rate and extended runway indicate stability and sustainability.
• Growing market share points to a higher number of customers adopting the product.

Key performance indicators help you estimate when should you raise external capital. You’ll also include the numbers in one of the slides of the pitch deck. Note that investors closely monitor these statistics, as they demonstrate the startup’s upward growth trajectory and operational efficiency.

Strong metrics convince investors that the startup has the potential and capability to scale rapidly. Metrics that match industry benchmarks and ongoing trends have a higher chance of attracting capital. The lower risk factor positions you to negotiate for favorable terms more aggressively.

Using visuals to depict your KPIs creates a lasting impression. Check out this video in which I have explained the types of charts you should use in pitch decks.

Robust Financial Health

The importance of having robust financial health may seem paradoxical when you need funding for growth. However, if you have steady incoming revenues and cash flows and consistently exceed financial projections, that’s a positive sign. It demonstrates that the startup is stable.

Pay special attention to the break-even point. Investors analyzing your financials focus on liquidity, profit generation, debt, and accounts payable. A good cash flow shows sound financial management, which is crucial for scaling the startup.

However, if the cash flow is sluggish, you might want to consider microfinance, bridge loans, or lines of credit instead. The money can help you handle shortfalls without risking dilution or unaffordable interest rates.

Note that the importance of financial health metrics depends on the startup’s growth stage and the type of funding round. Investors understand that a startup raising a seed funding round may not have financials as robust as those of a Series A.

Furthermore, the specific sector influences investor perception of financial health. Industries such as technology, healthcare, finance, and pharmaceuticals are innovation-centric, and a startup’s disruptive product portfolio may carry more weight.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you, take a look at the template created by Peter Thiel, the Silicon Valley legend (see it here), which I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Demand Exceeds Production Capabilities

Is the startup struggling to meet current demand? You’ll need to upgrade your manufacturing capabilities by investing in tools, machinery, and equipment, as well as the skills to run your operations effectively.

If the company’s core capacity is falling short of customer requirements, it’s time to raise funding. At the same time, you’ll conduct in-depth market research to analyze current and projected demand.

You’ll also analyze customer purchasing trends and future market size. Ramping up production is only advisable if you anticipate consistent demand. Before investing in facility upgrades, analyze operational efficiency. If you can raise manufacturing levels without major costs, that’s preferable.

Raising Capital to Achieve Strategic Goals

Once the startup is stable with healthy margins, has an established customer base, and an optimum product-market fit, it’s time to scale to the next stage. You’ll approach investors for funding to achieve your objectives and realize your vision for the startup’s future.

Where do you see the company headed next? Expansion across state borders or to a broader buyer demographic? Or maybe developing an advanced product portfolio. Whatever your objectives, ensure you connect with investors whose investment criteria align with your own.

The partnership should support your company through further growth cycles while allowing it to grow organically. They should also have the patience and confidence in your capabilities as a founder to deliver the returns you’ve committed to.

In Conclusion

When should you raise external capital vs. continuing with the bootstrapped business model? This decision is not an easy one, and your best bet is to partner with an experienced funding consultant.

You’ll get guidance on identifying the core metrics that indicate the startup is poised for rapid growth. Also, get advice on how much funding to raise and the sources to approach. Most importantly, you can take your time weighing the pros and cons before making the final decision.

You may also find our free library of business templates interesting. There, you will find every single template you need to build and scale your business completely, all for free. See it here.